DEMAND

ENGINEERING ECONOMICS

Theory of Demand : Meaning of Demand, Definition of Demand, Determinants of Demand, Demand Function, Demand Equation, Law of Demand, Statement of Law of Demand, Assumptions of Law of Demand, Exceptions of Law of Demand, Extension and contraction of Demand, Increase and Decrease in Demand, Reasons for change in Demand, Demand Forecasting : Meaning, Definition, Importance of Demand Forecasting, Purpose of Short-term Forecasting, Forecasts, Steps Involved in Demand Forecasting, The Purpose of demand Forecasting differs according to the type of forecasting, Techniques of Demand Forecasting, Criteria of a Good Forecasting Method

Demand is • Demand is desire/want backed by money (Demand=desire+ ability to pay+ will to pay) • Demand is always related to price and time (example :demand for oranges by a household at a price of Rs. sales depends on market demand . but in economics demand refers to effective demand i. taken together. the amount buyers are willing to purchase at a given price over a given period of time. It is a single consuming entity’s demand. It is the aggregate of the quantities of a product demanded by all the individuals buyers at a given price over a given period of time-it is the sum total of individual demand function.so does planning future marketing strategy Prices are determined on the basis of demand for the product etc. Market demand is more important from the business point of view. Market demand : It refers to the total demand of all buyers..DEMAND Meaning of Demand 2 Demand means desire/want for something.50/kg is 5kg oranges /week) • Demand may be viewed as Ex Ante (intended/potential demand)or Ex Post (amt actual purchased/actual quantity demanded) Definition of demand The demand for a product refers to the amount of it which will be bought per unit of time at a particular price. The following table shows individual demands for eggs and how the market demand eggs at various prices derived from it: Price /doz Rs 10 9 8 7 6 5 4 1 2 3 4 5 6 7 A B 3 4 5 6 7 8 9 C 0 1 3 5 6 7 8 D 0 0 1 2 3 4 5 E 0 0 0 1 2 3 4 Total dd for eggs 4 7 12 18 23 28 33 ENGINEERING ECONOMICS 2013 .e. Individual demand/Market demand Individual demand : It refers to demand from the individuals /family/house-hold.

X1.the amount demanded of the commodity Px.. Pc.. Ps. The most important variables are listed below: • The ‘own price’ of the product (P) • The price of the substitute and complementary goods(Ps or Pc) • The level of disposable income(Yd) with the buyers(i. Qd –quantity demanded ENGINEERING ECONOMICS 2013 . income left after direct taxes) • Change in the buyers’ taste and preferences(T) • The advertisement effect measured through the level of advertising expenditure(A) • Changes in the population number or number of buyers(N) Using the symbolic notations. N. Preferences • Relative price of other goods-substitutes and complementary goods • Consumers Expectations • Advertisement Effect MARKET DEMAND • Price of the product • Distribution of wealth and income in the community • Community’s common habits and scale of preferences • General standard of living and spending habits of the people • Growth of the population • Age structure/sex ratio of the population • Future Expectations • Level of taxation and tax structure • Fashions/inventions/innovations/customs/weather/climate • Advertisement/sales propaganda 3 DEMAND FUNCTION At any point of time. Habits.X2………….e. T. Yd. the quantity of a given product (good/service) that will be purchased by the consumers depends on a number of key variables/determinants.price of x u.other unspecified determinants of the demand for commodity x It can also be expressed as Q d= f(P. the demand function can expressed as follows: D x =f (Px. u) Where x –commodity Dx .Xn) Where. A.DEMAND Determinants of Demand INDIVIDUAL DEMAND • Price of the products • Income • Tastes.

DEMAND P –price X1.Having a minus sign denotes a negative function. a demand schedule may be constructed as below Demand schedule for commodity X Price per unit Rs.4 and 5 alternatively. So demand function is denoted as Dx= f(Px) This denotes that demand for commodity x is the function of its price. i. Demand Equation A linear demand function may be stated as D = a – bP Where.e..amount demanded a . the price and the quantity demanded. expect for price.X2………. D .3. To illustrate a demand equation & the computation of demand schedule assuming estimated demand functions.2Px.2. as Dx = 20 . It simply states that demand varies inversely to change in price. ENGINEERING ECONOMICS 2013 ..Xn –other determinants of demand 4 In economics. the given prices per unit of the commodity X are: Rs. In relation to these prices. demand for a commodity is a decreasing function of its price.Denotes functional relationship b/w (P) & (D) P . a very simple statement of demand function is adopted where all variables that determine demand are held to be constant.is a constant parameter which signifies initial price irrespective of price b .1. where Dx = Amount demanded for the commodity X Px = Price of X Suppose. (Px) 1 2 3 4 5 Units Demanded (Dx) 18 16 14 12 10 LAW OF DEMAND The law of demand expresses the nature of functional relationship b/w two variables of the demand relation viz.

larger the quantity demanded Other things remaining unchanged . the higher the price of a commodity the smaller is the quantity demanded and lower the price .DEMAND Statement of law of demand 5 Ceteris paribus. D= f (P) Price of commodity X (in Rs) 5 4 3 2 1 Quantity demanded (units per week) 100 200 300 400 500 The schedule for commodity X.demand varies inversely with price So. ENGINEERING ECONOMICS 2013 . as price falls demand raises so there is an inverse relationship b/w price and quantity demanded. Assumptions of law of demand The law of demand is based on certain assumptions • No change in consumer’s income • No change in consumer’s preferences • No change in fashion • No change in the price of related goods • No expectation of future price changes or shortages • No change in government policy etc.

Century people were so poor that they spent a major part of income on potatoes and a small part on meat. Giffen’s paradox is seen the case of inferior goods like potatoes. cheap bread etc. rose the demand also rose since they could not substitute it for meat which was very expensive. Speculating the prices of the commodity will further increase they will demand more of the commodity for hoarding etc. • Speculation: when people speculate about prices on the commodity in the future they may not act according to the laws of demand. So increase in price will lead to increase in demand for such goods. • Article of snob appeal: Certain commodities are demanded because they happen to be expensive or prestige goods or snob value having a status symbol. In the stock market. discounted sale . Diamonds . as price of potatoes. demand will also rise. where there is a direct relationship b/w price and demand (as shown in fig-2).exclusive cars etc. people tend to buy more shares when prices are rising in the hope of bull runs in anticipation of future profits.g.DEMAND Exceptions to the law of demand 6 The upward sloping curve is contrary to the law of demand. in spite of price rise. etc. These exceptional cases can be listed as • Giffen goods: In the case of certain inferior goods called Giffen goods (named after Sir Robert Giffen). E. ENGINEERING ECONOMICS 2013 . • Consumer psychological Bias: when a customer is wrongly biased against quality of a commodity a fall in price may not lead to an increase in demand example clearance of stock . It was seen in Ireland in 19th.

In the following diagram. habits and preferences Change in distribution of wealth and population Change in demand of complimentary / substitute goods Change in tax structure Change in value of money ENGINEERING ECONOMICS 2013 . Change in demand thus implies an increase or decrease in demand with price remaining constant. demand increases from a to b and then decreases to point c indicating various changes to demand due to price change. Reasons for change in Demand:       Changes in income Changes in taste. An increase /decrease signify either more or less will be demanded at a given price. This is represented graphically by movement of the demand curve upwards (in case of increase in demand) and downward movement of demand curve in case of decrease in demand. Increase and decrease in demand Changes in demand are a result of the change in the conditions / factors determining demand other than price. A change in demand due to change in price is called extension or contraction of demand. It is a movement along the same demand curve due to changes in price.DEMAND Extension and contraction of demand • • • 7 A variation in demand implies extension or contraction of demand.

DEMAND  Effect of advertisement and publicity 8 ENGINEERING ECONOMICS 2013 .

Demand forecasts are necessary since the basic operations process. Determining appropriate price policy. Most firms cannot simply wait for demand to emerge and then react to it. once a customer order materializes. “Demand forecasting is an estimate of demand during a specified period. ENGINEERING ECONOMICS 2013 . moving from the suppliers' raw materials to finished goods in the customers' hands. they must anticipate and plan for future demand so that they can react immediately to customer orders as they occur. In other words. it can be fulfilled immediately – since most customers are not willing to wait the time it would take to actually process their order throughout the supply chain and make the product based on their order. or retailer. Instead. Setting sales targets & establishing controls & incentives. and through to the eventual shipment of the order to the customer. Thus. Purpose of short-term forecasting       Appropriate production scheduling so as to avoid the problem of over-production & the problem of short-supply. Definition According to Cundiff and Still. Helping the firm to reducing costs of purchasing raw materials. through manufacture of the product. In other words. Forecasting short-term financial requirements. produced.DEMAND 9 DEMAND FORECASTING A forecast is a predication or estimation of a future event which is most likely to happen under given conditions. An order cycle could take weeks or months to go back through part suppliers and sub-assemblers. takes time. Evolving a suitable advertising & promotion programme. it tells the expected level of demand at some future date by considering the past and present behavior pattern of the related event. most manufacturers "make to stock" rather than "make to order" – they plan ahead and then deploy inventories of finished goods into field locations. and shipped. manufacturer. Forecasts of future demand will determine the quantities that should be purchased. Meaning of Demand Forecasting Demand forecasting refers to the predication of the probable demand for a good or a service on the basis of the past events prevailing trends in the present. Which estimate is tied to a proposed marketing plan and which assumes a particular set of uncontrollable and competitive forces.” The Importance of Demand Forecasting Forecasting product demand is crucial to any supplier.

This will help us in identifying the approach of forecast exercise. type of data available. 3. necessary to determine the class in which the good falls.) which have not entered the exercise of forecasting. sales planning. Further. Most of the times the forecast results are to be well supported by the background factors (like the government policy. Forecasts    Short-term forecasts. As planning for raising funds requires considerable advance notice. Determining the Nature of Goods: Different category of goods such as consumer and capital goods. in the first instance. Steps Involved in Demand Forecasting For efficient. It is therefore. Planning long-term financial requirements. medium-term forecasts. 4. involving a period up to twelve months. we need to frequently revise the forecast in the light of changing circumstances because forecasts are. Then different methods may be required for short term and long term forecasting. long –term sales forecasting are quite essential to assess longterm financial requirements. international economic. the following steps are necessary: 1. to a large extent. short-term forecasts. upon the efficiency in the interpretation of its results. political and social scene etc. availability of trained personnel. Planning man-power requirements. period for which the forecast is to be made. Long-term forecasts. made on the assumptions of continuation of past events. existing goods and new goods etc. durable and non-durable goods. The purpose of demand forecasting differs according to the type of forecasting. Inventory control etc. (1) The purpose of the Short term forecasting: It is difficult to define short run for a firm because its duration may differ according to the nature of the commodity. taking considerable time to complete. Medium-term forecasts. Identification of Objective: It is necessary to be clear about what does one want to get from the forecast. Selection of Proper Method: The selection of an appropriate method of forecasting is related to the objective of forecasting. Interpretation of Results: Efficiency of a forecast depends. general business environment. Training & personnel development are long-term propositions. involving a period from one to two years. long-term forecasts. accurate and meaningful forecast of demand. For a highly sophisticated automatic plant 3 months time may be considered as ENGINEERING ECONOMICS 2013 . A multi-product firm must ascertain not only the total demand situation. but also the demand for different items separately. involving a period of three to ten years. like the quantity and composition of demand.DEMAND   10  Planning of a new unit or expansion of an existing unit. have their own distinctive demand patterns. 2. price to be quoted. The purpose of the exercise may be the estimation of one or more than one aspect. The approach to the problem will accordingly differ.

    Planning for a new project. the other is to use past experience as a guide through a set of statistical techniques. 1) Experts Opinion Poll: In this method. There are specific techniques which fall under each of these broad methods. These experts. Proper management of inventories Evolving suitable price strategy to maintain consistent sales Formulating a suitable sales strategy in accordance with the changing pattern of demand and extent of competition among the firms. dealing in the same or similar product. are able to predict the likely sales of a given product in future periods under different conditions based on their experience. (2) The purpose of long. Fluctuations of a larger magnitude may take place in the distant future.term forecasting: The concept of demand forecasting is more relevant to the long-run that the short-run. there are two approaches to demand forecasting. diversification and technological up gradation.DEMAND 11 short run. Time duration may be set for demand forecasting depending upon how frequent the fluctuations in demand are. while for another plant duration may extend to 6 months or one year. expansion and modernization of an existing unit. If the number of such experts is large and their experience-based reactions are different. In this set of methods. such survey methods are often employed. shortterm forecasting can be undertaken by affirm for the following purpose. the latter for long-term forecasting. while in stagnant economy it may go up to 20 years. More over the time duration also depends upon the nature of the product for which demand forecasting is to be made. Techniques of Demand Forecasting Broadly speaking. Simple Survey Method: For forecasting the demand for existing product. Both these methods rely on varying degrees of judgment. The first method is usually found suitable for short-term forecasting.      Appropriate scheduling of production to avoid problems of over production and underproduction.one is to obtain information about the likely purchase behavior of the buyer through collecting expert’s opinion or by conducting interviews with consumers. Evolving a suitable strategy for changing pattern of consumption. we may undertake the following exercise. Arranging suitable manpower. then an average-simple or weighted –is found to lead to ENGINEERING ECONOMICS 2013 . Assessing long term financial needs. In fast developing economy the duration may go up to 5 or 10 years. the experts on the particular product whose demand is under study are requested to give their ‘opinion’ or ‘feel’ about the product. The purposes are. It takes time to raise financial resources. It can help a firm to arrange for specialized labour force and personnel. It is comparatively easy to forecast the immediate future than to forecast the distant future. Forecasting financial requirements for the short period.

3) Consumers Survey. The trend method outlined above often yields a dependable forecast. 2) Reasoned Opinion-Delphi Technique: This is a variant of the opinion poll method.DEMAND 12 unique forecasts. it is not feasible where a large number of consumers are involved. Such feedback may result in an expert revising his earlier opinion. But it is a very tedious and cumbersome process. thus generates “reasoned opinion” in place of “unstructured opinion”. or it may be exported as well as imported. This may lead to a narrowing down of the divergent views (of the experts) expressed earlier. Such methods are taken usually from statistics. the time series data on the under forecast are used to fit a trend line or curve either graphically or through statistical method of Least Squares. As such. you may be quite familiar with some the statistical tools and techniques. the forecaster selects a few consuming units out of the relevant population and then collects data on their probable demands for the product during the forecast period. The Delphi Techniques. The demands for final consumption and exports net of imports are estimated through some other forecasting method. The principle merit of this method is that the forecaster does not introduce any bias or value judgment of his own. If the sample is properly chosen. Once this information is collected. The trend line is worked out by fitting a trend equation to time series data with the aid of an estimation method. the forecaster undertakes a complete survey of all consumers whose demand he intends to forecast. The only limitation in this method is that it assumes that the past is repeated in ENGINEERING ECONOMICS 2013 . and its demand for intermediate use is estimated through a survey of its user industries. it only needs the time series data. then it will yield dependable results. (1) Time series analysis or trend method: Under this method. 4) Consumer Survey-Sample Survey Method: Under this method. A product is used for final consumption or as an intermediate product in the production of other goods in the domestic market. but the choice of sample is very critical. Here is an attempt to arrive at a consensus in an uncertain area by questioning a group of experts repeatedly until the responses appear to converge along a single line. Complex Statistical Methods: We shall now move from simple to complex set of methods of demand forecasting. The participants are supplied with responses to previous questions (including seasonings from others in the group by a coordinator or a leader or operator of some sort). The total demand of sample units is finally blown up to generate the total demand forecast. Sometimes this method is also called the ‘hunch method’ but it replaces analysis by opinions and it can thus turn out to be highly subjective in nature. The trend equation could take either a linear or any kind of non-linear form. this method is less tedious and less costly. the sales of a product are projected through a survey of its end-users. followed by the Greeks earlier. Moreover if the data are wrongly recorded. this method will be totally useless. He simply records the data and aggregates. otherwise there may be sampling error. the sales forecasts are obtained by simply adding the probable demands of all consumers.Complete Enumeration Method: Under this. The advantage in this method is that it does not require the formal knowledge of economic theory and the market. The sampling error can decrease with every increase in sample size 5) End-user Method of Consumers Survey: Under this method. and subject to less data error. as a part of quantitative methods for business decisions. but this is still a poor proxy for market behavior of economic variables. Compared to the former survey.

For example. (2) Barometric Techniques or Lead-Lag indicators method: This consists in discovering a set of series of some variables which exhibit a close association in their movement over a period or time. the lead period itself may change overtime. Sometimes the time series analysis may not reveal a significant trend of any kind. b1 is a component of price elasticity of demand. we shall not go into the question of economic theory. Such relationships. Through our estimation we may find out the bestfitted lag period on the past data. Thus if one knows the direction of the movement in agriculture income (AY). as we have seen earlier. In that case. the moving average method or exponentially weighted moving average method is used to smoothen the series.). income. Generally.DEMAND 13 future. b3 > 0 suggest that x is a normal commodity with commodity with positive incomeeffect. you must have covered those statistical techniques as a part of quantitative methods. but only the direction of change. this barometric method has been used in some of the developed countries for predicting business cycles situation. but the same may not be true for the future. based on past data can be used for forecasting. The leading indicator method does not tell you anything about the magnitude of the change that can be expected in the lagging series. The reflect the direction as well as proportion of change in demand for x as a result of a change in any of its explanatory variables. We shall concentrate simply on the use of these econometric techniques in forecasting. b2. advertisement etc. sales) and one or more independent variables (like price. ENGINEERING ECONOMICS 2013 . For example. For example. it is an appropriate method for long-run forecasts. b2< 0 suggest that DX and PX are inversely related. b4 > 0 suggest that x and y are substitutes. lagging or coincident indicators of the variable for which a demand forecast is being attempted. Some of the limitations of this method may be noted however. Also. Thus agricultural income (AY) may be used as a barometer (a leading indicator) to help the short-term forecast for the sale of tractors. but inappropriate for short-run forecasts. The analysis can be carried with varying degrees of complexity. Finally. Similarly. b3 and b4 are the components of relevant elasticity of demand. Here we shall not get into the methods of finding out ‘correlation coefficient’ or ‘regression equation’. is the use of economic theory. The form of the equation may be: DX = a + b1 A + b2PX + b3Py You know that the regression coefficients b1. 3) Correlation and Regression: These involve the use of econometric methods to determine the nature and degree of association between/among a set of variables. Econometrics. but the movement in ST takes place after a year’s time lag compared to the movement in AY. one can predict the direction of movement of tractors’ sale (ST) for the next year. it may not be always possible to find out the leading. some countries construct what are known as ‘diffusion indices’ by combining the movement of a number of leading series in the economy so that turning points in business activity could be discovered well in advance. For this purpose. We are on the realm of multiple regression and multiple correlation. The relationship may be expressed in the form of a demand function. it shows the movement of agricultural income (AY series) and the sale of tractors (ST series). statistical analysis and mathematical functions to determine the relationship between a dependent variable (say. Also. The movement of AY is similar to that of ST. you may recall.

In other words. The method is indeed very complicated. our focus is limited to micro elements only. In your earlier units. besides generating demand forecast. Availability: The techniques employed should be able to produce meaningful results quickly. For this. it explains why the demand is what it is. That is. this method can be used easily to derive meaningful forecasts. and (b) the extent of success in forecasting directional changes. we have made reference to such econometric models. related price (Py).DEMAND 14 Given the estimated value of and bi. (4) Simultaneous Equations Method: Here is a very sophisticated method of forecasting. similar to that of regression method. The principle advantage of this method is that it is prescriptive as well descriptive. Simplicity: Firms must be able to understand and have the confidence in the techniques used. 1. endogenous and exogenous variables affecting the variable under forecast. income (B) and advertisement (A). 4. in this course. this method is normally used in macrolevel forecasting for the economy as a whole. The regression method is neither mechanistic like the trend method nor subjective like the opinion poll method. if you know the future values of explanatory variables like own price (PX). as corporate managers. However. The only precaution you need to take is that data analysis should be based on the logic of economic theory. Lastly. However. The principle advantage in this method is that the forecaster needs to estimate the future values of only the exogenous variables unlike the regression method where he has to predict the future values of all. the persons making the ENGINEERING ECONOMICS 2013 . you. Understanding is also needed for the proper interpretation of the results. In fact. the better is the fit. In this method of forecasting. such econometric models have limitations. Criteria of a Good Forecasting Method The following criteria can be used for choosing the suitable method for forecasting. It is also known as the ‘complete system approach’ or ‘econometric model building’. The values of exogenous variables are easier to predict than those of the endogenous variables. this technique has got both explanatory and predictive value. Elaborate mathematical and econometric procedures may be judged less desirable if firms do not really understand what the forecaster is doing and fails to understand the procedure. It is not the question of results achievable but results achieved by a forecasting method. and that way you get a more reliable forecast. you may forecast the expected sales (DX). you may also recall that the statistics R2 (Co-efficient of determination) gives the measure of goodness of fit. you may use not only time-series data but also cross section data. Economy: Costs must be weighed against the importance of the forecast to the operations of the business. The accuracy of the forecast is measured by (a) the degree of deviations between forecasts and actual. Presently we do not intend to get into the details of this method because it is a subject by itself. 3. 2. in the days of computer. Moreover. Accuracy: It is necessary to check the accuracy of past forecasts against present performance and of present forecasts against future performance. Some comparisons of the model with what actually happens and of the assumptions with what it is borne out in practice are more desirable. should know the basic elements in such an approach. The closer it is to unity. Of course. when package programmes are available. And be readily available and well understood.

Longer the lead the forecast has before the event. One may even sacrifice some accuracy for gaining a ‘lead’ rather than sacrificing ‘lead’ for accuracy. their assumptions and probabilities. ENGINEERING ECONOMICS 2013 . Timeliness: There is a time gap between the occurrence of an event and its forecast– known as ‘lead’ time. the greater will be its usefulness. 5. But for a good forecast it is necessary that it should also predict deviations and turning points so that forecasts are more effective.DEMAND 15 decisions must fully understand the forecasting methods. Effective: It is quite easy to judge the existing trend. 6.

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